Friday, February 11, 2011

US weekly portfolio recommendation (from 14 to 18, Feb 2011)

The low volatility portfolio recommended for this week is (ticker notation):

'MO''AMGN''BCR''BDX''CVS' 'CPB' 'CLX''ED''FDO''GIS' 'HRL'

'JNJ''K''KMB''MKC''MCD''PEP''PG''RAI''SO''WEC'

This portfolio consists of 21 stocks. Although the strategy recommends different weights for each stock, to further improve the stability properties of the strategy, I recommend using equal weights for all the stocks.

In order to check the performance of this strategy over the last years, the strategy was run every four weeks in the past. In the next figure, the portfolio composition (number of stocks) from 2005 is shown.

It can be observed that the average number of stocks is around 20. This composition is reasonably stable over time, except during the crisis period where the portfolio composition is drastically reduced.

Regarding the performance, over the last year (52 weeks), the strategy attained a volatility of 10% (versus 17% of the S&P 500). The weekly 95%-VaR was 2.4% (versus 4.2% of the S&P 500). See this postfor the details about the back-testing.

In the next figure, we can see the evolution of the weekly 95%-VaR from 2006, over rolling 52-weeks periods.

We can see the portfolio VaR of the low volatility strategy is almost always below that of the S&P 500. This is not surprising because the portfolio composition is focused on minimizing the portfolio risk.

But more surprising is the return performance. The last year annualized Sharpe ratio of the low vol strategy was 1.7 (after proportional transaction costs of 40 bps was discounted). On the other hand, the SR of the S&P 500 was 1.4 over the same period.

To see if these results are consistent over time, next figure shows the evolution of the annualized SR from 2006, over rolling 52-weeks periods.

We can see most of the time the SR of the low vol strategy is larger than that of the S&P 500.

Finally, the correlation of the low vol strategy with the S&P 500 along the last 52 weeks was 84%.

In the next figure, we can see the evolution of the this correlation from 2006, over rolling 52-weeks periods.

We can see the correlation with the market index is above 75%, except during the crisis period where it lowers up to 60%. Note during the crisis period the portfolio composition was reduced to around 5 stocks (less risky).

As a summary, these extensive back-testing results confirm that low volatility portfolios continue to have low volatility in the future, and furthermore, they attain returns similar (or even better) than market indexes like the S&P 500.